What Is the &ldquo;Month-End Fix&rdquo; in Forex?

Over the past 24 hours, there has been a lot of talk about month-end fixings. Therefore, I think it is worthwhile to spend a few minutes explaining the foreign exchange market’s monthly obsession.

A few days ago, central banks around the world announced that the daily volume in the foreign exchange market has expanded to more than $4.1 trillion from $3.2 trillion in 2007. (These numbers are from the semi-annual reports by the central banks; we are still waiting for the Bank of International Settlement’s Triennial survey in August). The depth of liquidity in the FX market stems from large scope of participants who are buying and selling currencies for a variety of different reasons, including speculation, hedging, and trade-related activities.

Month-end fixings relate to the adjustments that international portfolio managers need to make to their currency hedges based upon the performance of the equity markets. These portfolio managers usually reweigh their portfolios at the end of each month if moves are larger than what they had anticipated. Their FX hedges protect their portfolios from volatility in the forex market because the worst thing that can happen is that stocks rise 10% but the currency falls 9%, erasing nearly all of the equity-related gains. This month in particular, everyone is saying that US dollars need to be sold on the fix because there was a sharp jump in the market value of US stocks and bonds during the month of July.

Barclays published this wonderful chart showing the changes in market value over the past month:

Click to Enlarge

Fixings are done at set times during the day and differ for each instrument, but the most popular fixing time is at the end of the day in the UK, which is known as the “London fix.” This occurs at 16:00 London time, or 12:00 NY time. Usually portfolio managers will either leave or give orders to dealing desks to be transacted at the fixing time and price.

Getting into the Specifics

Here are two very basic examples of how portfolio managers hedge.

Example #1: US Portfolio Manager

Let’s assume that you are a US portfolio manager with half of your holdings in American stocks and half in UK stocks. In the beginning of July, you have hedged 100% of your British pound currency risk. Since you are in the US, there is no need to hedge the dollar risk.

By the end of the month, the value of your US stocks increased by 10%, while the value of your UK stocks increased by 5%. If you want to maintain a 100% hedge, you would need sell 5% more pounds on July 30 to protect your portfolio against a decline in the British pound.
Example #2: German Portfolio Manager

Now let’s assume that you are a German portfolio manager with 50% of your holdings in US stocks and 50% in UK stocks.

At the end of July, you would need to sell both US dollars and British pounds to re-hedge your portfolio perfectly. However, more dollars would need to be sold than pounds because your US dollar-denominated investments increased substantially more in value than your UK investments.

On July 30, you call up your bank to conduct the hedges and repeat the same process next month.

Hopefully these examples have helped you understand why everyone is talking about the need to sell dollars for the “month-end fix” this month!